Vale SA

BOVESPA:VALE3

Earnings Call Transcript 2017-Q4

[Operator]

Good morning, ladies and gentlemen. Welcome to Vale's conference call to discuss the fourth quarter '17 and fiscal year 2017 results. [Operator Instructions] As a reminder, this conference is being recorded, and the recording will be available on the company's website at vale.com at the Investors link. This conference call and the slide presentation are being transmitted via Internet as well also through the Company's website. Before proceeding, let me mention that forward-looking statements are being made under the safe harbor of the Securities Litigation Reform Act of 1996. Actual performance could differ materially from that anticipated in any forward-looking comments as a result of macroeconomic conditions, market risks and other factors.

With us today are Mr. Fabio Schvartsman, President and CEO; Mr. Luciano Siani Pires, CFO; Mr. Peter Poppinga, Executive Director Ferrous Minerals and Coal; Mr. Eduardo Bartolomeo, Executive Director Base Metals; Mr. Luiz Eduardo Osorio, Executive Director Sustainability and Institutional Relations; Mr. Alexandre Pereira, Executive Director Business Support; and Ms. Marina Quental, Global People Director. First, Mr. Fabio Schvartsman will proceed to the presentation. And after that we will open for questions and answers.

It is now my pleasure to turn the call over to Mr. Fabio Schvartsman. Sir, you may now begin.

[Fabio Schvartsman, executive]

Good morning to all. Thank you very much for joining our conference call regarding the results of fourth quarter of 2017. I would like to start mentioning that we just closed this result of 2017 that was in our opinion a very good result and the quality of the balance sheet has improved meaningfully during the year.

Everything that we've been doing in the company in the last few months was related to become a more predictable company. And this translates for instance in the fact that we anticipated the results of the fourth quarter -- sorry in the fourth quarter of 2017 more or less in line with the actual results that were delivered, that we made of our focus in performance and in capital allocation our main goal in the company and in this purpose the first results of base metals are already showing the benefit for the company of this approach.

Because of this more careful capital allocation we were able to contain investments below $4 billion. And the good news about that that is this is sustainable. We can make it this way in the next several years.

Finally, regarding strategy, I would like to make a quick mention regarding the leveraging process of the Company that is evolving in a very proper way. We already reduced indebtedness by a lot and receiving the cash from the sale of Vale Fertilizantes and of the Nacala project. During the next few months we are coming to a very comfortable indebtedness level with these more or less coming to an end in the necessity of the leveraging of the company.

Next I would again emphasize that we want Vale to remain and to become a diversified company. But by that I don't mean that we are going to acquire other companies or we are going to start in other businesses, but much on the contrary we are going to start to realize more value from our existing assets, especially in base metals where we think that we have a big opportunity. And we are going to continue with the same discipline that we've shown in iron ore, being very cautious regarding how we evolve the production in order not to put too much pressure on the market.

A few things about 2018. First, I want to comment that we now have our team, the executive team of the company complete. We have a very good mixture of people that are coming from inside Vale and executives that are coming from outside in a very good balance for managing the company.

Next, commenting on our business in general, I would like to start with iron ore. Iron ore, our expectation regarding prices is that we given the growth that we can see in all the major economies in the world the expectation is that there will be no downward pressure on prices during 2018. So we are optimistic regarding where prices will stay and we are going to continue to invest in reducing costs in this iron ore division through supply chain optimization starting in a very determined way in digital transformation and we are going to continue the cost reduction process that started with Professor Falconi and in the matrix process of managing costs and expenses.

Obviously, it is of utmost importance to control the investments and therefore allocation capital will be key in this business during 2018. In base metals it's necessary to be a little bit more cautious given the volatility in the nickel prices. I think nobody can guarantee where prices of nickel will go in the near future. Nevertheless we are investing heavily in the transformation of this business. We brought in Eduardo Bartolomeo to run this business with the purpose of restructuring it and with the purpose in the year of 2018 of putting focus in Sudbury and in [ Nova ] Caledonia in February trying to extract more value off this excellent assets that belong to Vale. And in Nova Caledonia it's time to move from a start to the project that Nova Caledonia had till recently to start [indiscernible] bringing all the profitability and the benefits for the company.

The purpose of all that is to be cash positive in all of our operations and it is important to emphasize that it is the first time in many years that we are cash positive already in all of our sites that happened in the last 2 months for the first time I suppose ever.

Finally, in coal we are going to complete the path of Moatize in Nacala with the purpose of diluting fixed costs and we can expect the results to be better in the -- results of coal to be better in the first quarter of 2018 than they were in the fourth quarter of 2017.

Regarding results in Vale as a whole, it is our expectation that even taking to consideration that the first quarter is typically more weak in seasonal basis that we will be able to deliver the same kind of result that we had in the fourth quarter of last year.

And as a closing note, as we mentioned in our release, it is our purpose to deliver to the market a new dividend policy by the end of March. This policy that is -- will aim to be at the same time more aggressive and sustainable for long years of time.

That was my opening statement. And now I'm going to pass it to Luciano to give a more details information on the results of the last quarter of last year.

[Luciano Pires, executive]

So good morning, everyone. My intention is to walk you through a one single analysis of the '17 results which I believe shed some color on all of our strategy and some structural factors affecting Vale. For those who have the webcast it's Page 6 which shows a buildup from the EBITDA in 2016 to the EBITDA in 2017. For those who don't have it, I will give you the numbers.

So we start with $12 billion of EBITDA in 2016. And the very first effect which boosted our results is obviously, it's increase in prices, net effect of $3.8 billion. But there's an important factor I would like to call your attention which is we're netting in $3.8 billion, a downward effect of almost $700 million dollars of what we've been calling now in the release you're going to read procyclical effects of higher prices. What exactly is it that? This is not a typical cost inflation that many of you are thinking about in the industry. This is the direct linkage between some of Vale's costs to the iron ore and pellet prices. We're talking about the purchase of third-party fees, we're talking about royalties, we're talking about the leasing of some of our pelletizing plants, the contracts provide for a lease price, lease expense which is directly linked to the pellet premiums and we're talking about profit sharing.

The difference between this and other cost components is that if iron ore prices or pellet prices reverse, this immediately reverses as well, these are formula-based. But this is different from cost inflation which we're going to talk later. But this is the first component $3.8 billion net of these cyclical effects and costs, improving EBITDA.

The second effect is $1.4 billion approximately of improvement in premiums and commercial initiatives. So as you all know, our premiums for our high-end products have increased during the year, but also Vale proactively managed its product mix. Vale proactively is blending products and is proactively also renegotiating contracts to take advantage of this market moment. And sometimes when you do that you increase cost as a side effect. For example, if you blend you will increase cost, but you get better price realization. If you produce more pellets, which is the case this year, you also increase cost because to produce, to concentrate iron ore into pellet feed there's more costs associated. So the key here is that one should not look into Vale's performance just from the perspective of cost but has to have an integrated view and look at margins.

Now we come to the next component of the results which now all of them which I'm going to mention have diminished EBITDA. And now we've come to the overall theme of cost inflation in the industry. We start with $725 million of foreign exchange effect, both in Brazil and in Canada mainly, no comments on that. We now come to $409 million of bunker oil increases. And the key point here is that we're not going to just watch moves in the bunker oil prices. Vale has ongoing initiatives to reduce its short position and exposure to bunker oil prices over the long run. We're not talking about hedge here and in the right moment you'll get to know what these initiatives are all about.

There's another component of freight. Freight increased Vale's costs by $267 million. And as you know, we've been trying to actively manage our exposure to freight. We just received the first ship from the next second generation of Valemaxs which are more efficient than the first generation. And these are -- this is the first of about 30 new ships that are going to be delivered to Vale in '18 and '19 to help us manage down freight costs.

The next component with a cost increase of $215 million is energy costs, electricity costs mainly in Brazil. And here I have to tell you that we're open for business looking for opportunities to increase self efficiency at Vale. We produce 60% approximately of our own energy needs and we intend to go as high as 100% to avoid those impacts going forward.

And finally, as a last component there was indeed around $300 million of cost increases, endogenous cost increases in our operations, but they are all related to base metals and they're all related to the structural transition that went on in Sudbury in the second and third quarters, transitioning from 2 furnaces to 1 furnace and the stoppages in Manitoba in the first quarter. As a proof of that that these were one-off effects, if you look in the release at the fourth quarter cost performance for base metals we have all of our operations performing at cost levels below the '16 and the '17 average levels with a highlight for Ontario as well where the furnace transition took place.

So all-in-all that explains why the $12 billion came to be $15.3 billion in EBITDA. And in a nutshell, the key messages here is we are managing for margins and we are actively addressing the fundamental cost inflation factors that are starting to affect the industry. And now we can move for questions and answers.

[Operator]

[Operator Instructions] Our first question comes from Novid Rassouli, Cowen and Company.

[Novid Rassouli, analyst]

The first is on iron ore. You mentioned being cautious on how you progress iron ore production to not put too much pressure on the market. I just wondered if you can just speak to anything that would potentially make you adjust the current kind of 400 million metric ton run rate expected in 2019 and beyond or is that pretty much set in stone and you're talking about future increases from that point?

[Fabio Schvartsman, executive]

Okay. Look, our target of USD 400 million is here for staying, it is not something that we are going to change unless a structural change happens in the market because we do have this idle capacity that would allow us to go further than that, but we are not going to use it unless there is a meaningful change in the market. And this change is not anticipated by us in the next couple of years.

[Novid Rassouli, analyst]

And then in your release you mentioned that you forecast coal prices to lose steam throughout first half of '18 as supply normalizes. In the past we've seen lower coal prices having the ability to weigh on iron ore prices. Well, I was just wondering if you could speak to how you expect your coal forecast to potentially impact iron ore prices throughout 2018?

[Gerd Peter Poppinga, executive]

I think this is -- that there's a correlation like you said, but it's not coal it's actually more coke. The coke price, when the coke price goes very much up then you have, in our case, a favorable development for premiums. We are not a big player in the coal business. I would say we have a view on the long-term coal price which is a little lower than the prices of today. But the correlation you're mentioning is not a direct one I would say.

[Novid Rassouli, analyst]

And then just switching gears to copper for a second, and these are my final questions. I just wonder if you can give us your expectations for Chinese copper demand in 2018 as well as if you have a surplus or deficit forecast for 2018.

[Unknown Executive]

Well, from my limited knowledge we are stable since the last 2 years and it's going to be a small deficit this year not as high as nickel. Nickel is the one that is presenting deficit, so coal is more or less stable. But we have to see the movements that are happening for copper, I mean copper. On Chile on the labor movements there are some noise there but basically we think it is table, not as much as a nickel.

[Novid Rassouli, analyst]

And you outlined the 800,000 tons of disruption in '17. As you mentioned, there are significant labor contract negotiations taking place in '18. Any thoughts on if the level of disruption have the potential to reach what we saw in '17?

[Unknown Executive]

No, not is our operations at all.

[Operator]

[Operator Instructions] Our next question comes from Thiago Lofiego, Bradesco BBI.

[Thiago Lofiego, analyst]

I just have one follow-up question. I am not sure if you addressed that before. I'm sorry if you did. Just to clarify about an update on VNC, the potential to sell a stake. How is that evolving? What's the timing? I remember, Fabio you mentioned before that the potential timing was end of this year, if you could refresh us on that. And also about the needed CapEx there as well, are you already spending money on that or are you waiting for the deal to go through? And the second question also related to the same thing which would be on the cobalt potential divestment what kind of a deal are we talking about here? What's the potential size in terms of tonnages and also in terms of value and also timing?

[Fabio Schvartsman, executive]

Okay, Thiago, thanks for your question. No, we didn't comment on that yet. And thank you for giving us the opportunity of doing so now. In VNC and cobalt the idea is basically the same in both cases. We are working in a way that will guarantee that each and single one of our site is cash positive throughout the years. So the reason for using this kind of, let's say, nontypical financing is with the objective of facing the investments that we have to make. Firstly VNC because of the tailing and then [indiscernible] because of the underground mine that we had to invest here. And the process continues moving forward in both cases and the decision in the case of VNC is not expected before the end of the year where we have to come to this year. The size of the investment on the other hand has been recently reduced by the effort of further analyzing all the alternatives that could allow us to employ less capital to do the same investment. So we have good news in this subject as well.

[Operator]

Our next question comes from Humberto Meireles, Goldman Sachs.

[Humberto Meireles, analyst]

Question on iron ore production versus shipments. If you look at last year, production increased by around 30 million tons while shipments were flat. In the same time you had an offshore blending capacity increase by roughly 30 million tons. As you look into '18 the expectation in the target is increased blending by the same amount of last year. So how should I think about the gap between production and shipments, is it reasonable to expect similar magnitude that we saw last year? And put this question in another way is could you also provide the guidance not only on production but also shipments of iron ore for this year?

[Gerd Peter Poppinga, executive]

Okay, Humberto, thanks for the question. You are right, since we were building up stocks in Malaysia and in China the shipment production ratio was not normal. So what is a normal shipment production ratio? It's around 97.5% to 98% because you lose some material during the process and the pelletizing. So that's the normal ratio. So in 2017 instead of 97%, 98% this ratio was 94%, this was in 2017. So you saw in this quarter and the end of this quarter when you only take the fourth quarter you saw the ratio of 100% because we had, so we shipped actually more than we produced in the fourth quarter. Even though we are saying that we are going to -- we postponed some sales into the first quarter of next year. The first quarter of next year therefore will be a normal ratio which will be around 98%. Now the rest of 2018 will almost be there, will still have some, let's say, around 1% difference of a normal ratio and then in 2019 we will be fully normal again, 97% to 98%. So takeaway is first half -- first quarter of '18 you will have a normal ratio and then in the second half you will have maybe 1% less, still having some stocking building in China, and then in 2019 it will be completely normal again. Hope that helped. And the good thing is that this is the first quarter we are going to have a normal. Since we postponed some sales we have a normal ratio again in the first quarter.

[Humberto Meireles, analyst]

Just to make sure that I understand it. So if you look at last year, right, the offshore blending capacity increased by 30 million tons and as you described that required a lot of [indiscernible] but if you go to this year we have same offshore blending capacity increase by the same amount, so technically the inventory build-up will be the same, so why isn't it reasonable to work with a similar gap that -- delta that we saw last year?

[Gerd Peter Poppinga, executive]

Because we are blending less and less. The big blending, the big building of stocks happened last year and this year it will be little less. There will be still some inventory building up, but much less than 2017, and in 2019 it will be stable.

[Operator]

The next question comes from Carlos De Alba.

[Carlos de Alba, analyst]

I will try to squeeze 3 quick questions if I may. Fabio, if you could comment a little bit on the spirit of what you are trying to get in terms of the new dividend policy, you mentioned it is going to be more aggressive, more sustainable hopefully, but is the company trying to target a specific dividend yield, is it trying to target a specific payout ratio or a percentage of cash flow generation. If you could just generally speak about the spirit of this new dividend policy that will be useful. Second is in the comments in the press release once again you said that Vale will be a more predictable company. So for me, to be honest, it's extremely difficult given the link that you have to the commodity prices and obviously we have seen in last 18 months, 24 months they have been quite volatile and have come as a surprise to many of the forecasters, so what -- could you elaborate a little bit more about what specifically do you mean or how you plan to achieve that goal despite the volatility that we see in commodity prices? And then finally, Luciano, given the cost pressures that you alluded to in the call and also that were mentioned in the press release do you expect material changes to the guidance or outlook that was provided in the Vale Day in New York and London back in December. There were a few slides there that talk about a breakeven for iron ore, costs for nickel operations in 2020 year. Do you foresee many pressures or do you think the company will work and try and offset some of the pressures by other management initiatives?

[Fabio Schvartsman, executive]

Carlos, thank you for your questions. Starting with the dividend policy. Yes, as I -- as we've been mentioning we want the policy to be at the same time aggressive and sustainable. And the only way that I know to make it sustainable is to make it proportional to the cash generation of the company. Any other one will be outside of our control and so it's not going to be sustainable. That's the reason why you can expect something correlated to the cash generation of the company. Now regarding predictability, you are right commodity price are and will always be very volatile. It's true that we are making the effort that we can to dilute this effect with discipline in the production of iron ore, reducing capacity available of nickel in order to cope with bad moments in the market. That helps in the sense of reducing volatility because of this behavior of ours, that's the purpose. But by predictability I mean another thing. I mean that obviously we have to cope with changing prices environment all the time. And to be predictable in my way of thinking is that in any given price scenario you'll be -- the market and everybody has to be able to easily identify how Vale will perform. This is predictability, and this is only possible if you have full control in everything else, then the price of the commodity, meaning we have to have a very strict capital allocation policy, we have to have a constant focus in improving performance and we have to look very cautiously in all of our capital structure and cost structure in order to optimize it. By doing that we certainly will become a company that everybody will understand better and that's what I mean by predictability.

[Luciano Pires, executive]

Carlos, on the cost reductions, keeping cost and the external factors that I mentioned we continue to guide in iron ore to a $3 to $5 margin expansion until 2020. I mentioned in the earlier call that S11D alone should have a contribution of around $0.60 this year and that we are targeting to end this year below $14 per ton. But having said that, on the external factors, that guidance does not include any initiative to control and to lower energy and bunker prices, so this should be an upside. In the nickel operations, we've already guided for CAD 200 million cost improvements over 2 years in February, that doesn't change. And for this year across all the base metals operations there is a target also for a cost reduction of around USD 200 million, that doesn't change. Finally in coal because of the ramp up that needs -- the cost need to come down and they will come down simply because of higher volumes, you're seeing that story. Although in the short term we had a problem with an excavator which we'll be fixing. So no material changes to the guidance keeping external factors constant.

[Operator]

The next question comes from [ Gustavo Gregory ], Bradesco BBI.

[Unknown Analyst]

I have a quick question regarding debt. Given Vale's massive cash generations during fourth quarter and expected strong cash generation first and second quarter I wanted to see if you guys can give us a little bit more clarity on the company's strategy regarding what we can expect in terms of gross debt reduction and also take into account how relevant the market has become in Vale's debt portfolio, if the company has any preferences in terms of what bonds they could potentially tender or call.

[Luciano Pires, executive]

Obviously we will continue to reduce gross debt. You've seen in the fourth quarter some retirements of debt. We're kind of -- we returned a lot of debt with bilateral operations with banks but now naturally there will come a time when we will have to be more active in the capital markets. So we tendered for the 19 and 20 bonds last year and we will certainly -- we will have to come back to repurchase some of our outstanding bonds. We cannot give more details about where in the quarter we're going to act, but this is a natural consequence of having to retire that. Capital markets today represent about 55% if I'm not mistaken of Vale's total debt, so a repurchase of that has to pass through capital markets debt as well.

[Operator]

The next question comes from [ CJ Balbione ], Principal Global Investor.

[Unknown Analyst]

I realized this is a small part of your business but I'm curious with respecting your mine in Corumbá and the new port in Uruguay, do you intend to shift your minimum volumes under the agreement that you have or just pay the minimum guarantee? Hello?

[Fabio Schvartsman, executive]

Give us just a second.

[Luciano Pires, executive]

Look, we were just wondering how much did we have here, but maybe it is worth that we can, but if you have you want to go into much detail we could have a conversation later through Investor Relations but what I can tell you now is that Corumbá as we have done a very good work there in terms of reducing costs we have also renegotiated some of our take or pay contract with barges. But effectively we have actually reduced the volume. The volume in the past was much higher. We have -- we are not, we are not dealing with fines today, we are much more dealing with lump. We are focusing on lump and we have also renegotiated our contracts of our main clients, the Argentinians. So overall Corumbá has -- is now more competitive. But if you wanted to have some details, I invite you to -- through our Investor Relations we can provide you those details.

[Operator]

The next question comes from Alex Hacking, Citibank.

[Alexander Hacking, analyst]

I have a couple of questions for Peter, if it's okay. First one, Peter, the given the cost, some of the cost issues that you're saying but also the ramp-up of S11D, how do you expect your C1, your iron ore C1 cost to trend next year. And then the second question, could you just talk a little bit about how you're seeing demand for iron ore evolving outside of China? It seems like you've sold more material outside of China last year and obviously we're seeing China exporting less the rest of the world picking up but I'm curious on your perspective on that development.

[Gerd Peter Poppinga, executive]

Thanks Alex for the question. So on the C1, I think Luciano gave you earlier some guidelines, but what's happening to the C1, you can see that in 2017 we had C1 of $14.8, right? Now the main driver for the C1 of course is S11D. There is a big -- there's a reduction coming which will be captured in 2018. We estimate this being $0.50. And then we have the -- our productivity work with Dr. Falconi and our management, cost management, matrix cost management. So those things together we expect this to be around $1. Captured in 2018 of course this will go on into 2019. On the other hand we have a cost inflation, but you will also have probably foreign exchange variation. We are working -- if you work, for instance, with 3.3 -- if you name -- if you take a number of BRL3.3 this gives you probably an offset on the cost inflation which we know that it's coming, there's energy, there's services, there's diesel. So if you -- on a simple -- just simply offsetting FX and cost inflation, if you do that and you take the $1 I just spoke about then you come to the figures Luciano has talked that we are aiming, but it's going to be possible to be under $14 in C1. This is concerning all of Vale. And C1 and S11D, if you specifically take S11D, it's a very nice surprise, we are in the first 2 months we're on the run rate of 46 million tons a year which is exactly what we are targeting for a ramp-up and this in a raining season is good. So -- and if you take the cost of that and exclude the capacity which is not utilized which must be utilized and not counted so you come close -- you come very close to those figures we presented in Vale Day in New York. So it's all going well in S11D. And again, we are targeting -- in spite of cost inflation we are targeting C1 costs slightly lower than $14 in next year. And then the other markets you mentioned outside China, that's the good thing, that's the good surprise that was booming. We see the Middle East very, very demanding. We are increasing our sales in Eastern Europe. Also Europe is picking up strongly because it is like that 2.5% higher steel production and consumption probably happening this year. So it's very positive and China of course is our main market but we shouldn't forget about the rest of the world.

[Operator]

The next question comes from Marcos Assumpção, Itaú BBA.

[Marcos Assumpção, analyst]

First question on pellets, if you think that the startup of the Tubarão and some lease plans expected for the coming quarters if this could have an impact on the pellet premium in the coming quarters? And the second question to Fabio, talking about governance in the future. A lot has been done in the past year, but what is your view or your vision for the corporate governance of the company? How do you think you could still improve in the coming years? And also considering the end of the lock-up period of some of the controlling shareholders, if you believe that sooner rather than later we could have a reshuffle on the Board of the company?

[Gerd Peter Poppinga, executive]

Marcos, thanks for the question. On the pellet, on the pellet, the only thing I'm -- I cannot speculate, it's too early to speculate on the how will be the premiums next year. And the only thing I can tell you is that we have a huge overbooking, a huge overbooking and this earlier startup in Tubarão I and II and a normal timing of the northern pellet plant in the second half of this year will only help us to reduce the overbooking. So it's a very stressful situation today because we have to manage all these overbooking and all these spot business and people coming in want pellet. But maybe it's going to be slightly better in the second half because of the ramp-up, but it's too early to talk about premiums of next year.

[Fabio Schvartsman, executive]

Okay, Marcos, regarding your question on governance, we are evolving in the process of perfecting the governance of Vale. We are on the road to becoming a true corporation and there is a lot to learn how to work with the Board, the relationship between the Board and the Executives. These are all new stuff for everybody and this transition is moving smoothly and we are -- both sides we are learning how to do this. Now we have a number of committees that is starting to supervise everything that a company is doing. So and we, the Executives, we have to participate in these committees and we have to feed this committees in order to make a better decision-making process. So we are in the -- we are learning. And in the next couple of years we are going to become a real corporation and behave as a proper corporation. Regarding the lockup, yes, the lockup is gone. The controlling shareholders could have the -- the former controlling shareholders would have the alternative of selling the stock. They are certainly analyzing that. But one thing you rest assured, nothing will be done in a not-taught way, meaning it will be organized, it will be -- if it happens through a follow-on in order to preserve the value of the company. So we are all very attentive to this fact given the size of the follow on that can be possible out of the intention of the controlling shareholders.

[Operator]

The next question comes from Andreas Bokkenheuser, UBS.

[Andreas Bokkenheuser, analyst]

Just 1 question on the iron ore premium. You mentioned it a little bit this morning on the Portuguese call as well and you've said before that you think the iron ore, the high-grade iron ore premium is structural. But we always -- we're also seeing a lot of it having to do with steel profitability in China, we got the whole pollution restriction debate in there as well. I guess my question is if a lot of this is driven by steel profitability and of course steel profitability is extremely cyclical in nature, then how high is your conviction that the high-grade iron ore premium is really structural when it's tied into something as cyclical as steel margins effectively? Thank you. That's my question.

[Gerd Peter Poppinga, executive]

Andreas, thank you for your question. Again I think we have had a major shift in the industry. We have had a supply side reform where we have the capacity closures and move to bigger blast furnaces. So this is actually something interesting. It's not the Chinese invention. If you remember in the past how things happened in Japan and Korea, it was more or less the same. So I guess China is more and more adopting the operating philosophy of other developed countries. And the coke price is expensive and it generates pollution, so less consumption is important. Now the third element in all this is what you mentioned is the high steel margins. If you take this element out for sure there is maybe, it can be eased a little bit the need for high material -- high quality material, but you cannot simply with -- move to big blast furnaces. And knowing that the coke inside China will be expensive, and there is the pollution thing, it is simply impossible to improve productivity and utilization because you've closed lots of capacity. So the remaining blast furnace, they have to produce more than the rest. It's impossible with this structural reality to reduce emissions without improving quality of the raw materials. So iron ore high grade in our opinion will be priced higher, substantially higher than just the value of the contained additional iron units, that is for sure. And I think maybe there will be some fluctuations, some volatility in the premiums. Cyclical factors will play a role but the shift to the flight to quality is definitely a structural one.

[Fabio Schvartsman, executive]

If I can help here. We have this combination of growth everywhere in the world therefore increasing demand for steel everywhere. Plus the antipollution matters in China that are for real, it seems quite unlikely that we are going to see any changes in the behavior of this marketing in the next couple of years at least.

[Operator]

The next question comes from Jon Brandt, HSBC.

[Jonathan Brandt, analyst]

2 questions from me first on Samarco. Wondering if there's any update on a potential restart and if there has been any negotiations with BHP for potentially buying their stake? And second I guess I just wanted to come back to VNC with cash costs dropping pretty substantially in the fourth quarter how much of that was related to by-products, [indiscernible] specifically cobalt and how much of it was related to better efficiency and sort of your internal measures. And with the expectation that cobalt prices should continue to rise given [ EV ] technology how much does that play into whatever decision you make with VNC and considering [indiscernible].

[Fabio Schvartsman, executive]

Very good. Thank you for your questions. Regarding Samarco I want to emphasize once again that we think and I am mentioning things in my name and the name of BHP as well, we both think that we have a responsibility in this case, a very special one given the disaster that happened in Samarco. We are trying everything that we can to make the restart of the plant, of the mill feasible. And this is our main focus and we are not spending time in anything else at this point. And both of us, we don't see Samarco as a business opportunity, we see Samarco as a social obligation where we are doing everything that we can to restart. Regarding VNC, obviously cobalt prices, the byproduct in VNC, they play a role in the cost reduction. But this is -- was the smallest part. We are talking like 30% of the cost reduction came from came from the cobalt and 70% from the efficiency and ramp up of the mill. That make us more optimistic about VNC of course. And the recent improvement in prices are making us more optimistic as well. The truth is that we are waiting to see where things are going to move forward in order to make a decision how to deal with the VNC situation. It's clear that the situation now is different from where we were 6 months ago. And so we are reacting accordingly.

[Operator]

The next question comes from Chris Terry, Deutsche Bank.

[Chris Terry, analyst]

Few questions from me. I think on Slide 6 when you step through the EBITDA from 2016 to 2017 you spoke about the energy costs a little bit and alluded to the fact that you might have some opportunities there. I just wondered if you could expand on that a little bit and perhaps just a bit more color on the bunker fuel costs, how you control those costs going forward. That's my first question. The second question is just around, you're looking at the new dividend policy, so obviously the balance sheet is in good shape and trending down. Can you perhaps just talk a little bit around Salobo and potential decisions would be made there. And then my last question is just on the cost efficiency program in the $150 million mentioned on potential cost reduction.

[Fabio Schvartsman, executive]

Yes, let's start making a quick comment on bunker. On bunker we are trying several different approaches. One of them being clearly reducing our demand of bunker. We are working on changing the model that we operate our ships in order to have less dependence upon a bunker. This obviously will happen during time.

[Luciano Pires, executive]

Okay. On energy costs, the total electricity bill around Vale is around $600 million per year. And about -- as I said about 60% of that is on production by Vale and the rest is a mixture of long-term contracts and also spot transactions. Spot prices in Brazil have been fluctuating a lot depending on the hydrology because they were very dependent of hydropower generation. And sometimes spot prices can be three times as large as the internal self-generation of Vale. And the contracts when they are renewed they also reflect somehow the view on the supply and demand of electricity in Brazil going forward. So we are still very exposed to energy. And rule of thumb would be that perhaps this 40% where we are exposed to market forces cost around twice the price of own self-generated energy. So from these numbers I believe you can figure what the size of the opportunity is if we generate 100% of our own needs.

[Fabio Schvartsman, executive]

Now in your question regarding dividends. Vale is now in a very particular moment. We are the company in the mine in the iron ore universe that has the ability now of not investing to keep capacity. We had just made a huge investment in S11D. We have plenty of capacity and therefore we have the opportunity of enjoying this moment. And the way we are planning to enjoy it is to be able to pay back to our shareholders dividend wise the patience that they gave us during the construction and the investment cycle that we were. So dividends, as I mentioned before, will become a proportion of our cash flow generation in order to make it aggressive and sustainable.

[Unknown Executive]

Okay. About the $150 million dollars of cost reduction, just to give more clarity. As Luciano mentioned in his initial remarks we made the change in Sudbury for the single furnace, so now it's time to harvest that investment. We are looking for a multi-year cost reduction over 2, maybe 2 elements, one is the rightsizing the organization to put this new flow sheet. So we still have a larger organization that is needed to run it. And the second one is the productivity that we will win from both the process plants and mainly the underground mines with the huge gap on the underground mines. So I think both areas will achieve this CAD 200 million that are $150 million. I hope it made it clear.

[Fabio Schvartsman, executive]

Wanted to comment on that, just a little more color. We are planning to have in 2018 10% less cost in all of our nickel operations and this is way more than $150 million.

[Chris Terry, analyst]

And just following up on the second question related to the balance sheet, is there a timeline that you have in mind for making decision on the Salobo expansion?

[Gerd Peter Poppinga, executive]

This is on the FEL 3, it's going to be taking the decision this year. So it's a normal process. We are just finalizing the engineering studies and we are moving forward to the Board in the end of the year, normal procedures.

[Operator]

The next questions comes from Tyler Broda, RBC. His line has dropped. This concludes today's question-and-answer session. Mr. Fabio Schvartsman at this time you may proceed with your closing statements.

[Fabio Schvartsman, executive]

Well, once again we appreciate very much having you in this call. And we are evolving in a very different way towards becoming a more predictable company and a company that you can -- that you know what to expect in any given circumstance and therefore I ask you to join us again in the next call to give us a chance to show you that we've been walking the talk the way we have described. Thank you so much and have a wonderful day. Bye-bye.

[Operator]

That does conclude Vale's conference for today. Thank you very much for your participation. You may now disconnect.